West v. First Baptist Church (123 Tex. 388, 1934)

Mr. Judge SMEDLEY

of the Commission of Appeals delivered the opinion for the Court.

The First Baptist Church of Taft, for the purpose of constructing a church building on lots owned by it in Taft, Texas, made application to Southern Mortgage Company, of Abilene, Texas, for a loan of $20,000. Before the building was begun, the church, on the request of the mortgage company, executed and delivered to the mortgage company for the purpose of “closing the loan” twenty-two promissory negotiable notes aggregating the principal sum of $20,000, payable to Southern Mortgage Company at the office of Mortgage and Securities Company in New Orleans. At the same time the church executed a deed of trust securing the notes and covering the lots upon which the church was to be built and also other lots owned by the church upon which a parsonage was situated. This deed of trust expressly provided that it covered also all buildings, fixtures, furniture, and equipment then located or thereafter to be located upon the lots upon which the church was to be built. A second and subordinate deed of trust was executed securing the two other promissory negotiable notes payable to Southern Mortgage Company, aggregating the principal sum of $1,000. The notes and deeds of trust, while dated March 9, 1929, were in fact executed May 2, 1929. On the same day, at the request of Southern Mortgage Company, the church caused the two deeds of trust to be filed for record in the office of the county clerk of San Patricio County, and on May 8, 1929, pursuant to the same request, the church mailed the notes to Southern Mortgage Company at Abilene, together with a certificate of the county clerk showing that the two deeds of trust had been filed for record.

It had theretofore been agreed, in the course of the negotiations for the loan, that none of the money should be paid to the church until the building had been entirely completed according to the plans and specifications. It had further been agreed by Southern Mortgage Company that the notes would be held by it in Abilene “until after the money was furnished on the loan.”

The church made arrangements with the Taft Bank, Unincorporated, whereby the bank agreed to furnish money to the amount of $20,000 to pay for labor and material in the construction of the building, the money to be advanced as the work progressed and to be repaid the bank when the proceeds of the loan from Southern Mortgage Company were procured. There was an oral agreement between the church and the bank that the bank should have a lien to secure the money so advanced.

Building operations were begun about May 2, 1929, the bank advancing something more than $20,000, which was used in payment for labor and material. The building was completed about October 1, 1929, after the trial of this suit in district court.

A short time after receiving the notes Southern Mortgage Company forwarded them to Mortgage and Securities Company at New Orleans, advising that the construction of the building had just begun and that some time would elapse before the loan would be ready for closing. Southern Mortgage Company was a subsidiary of Mortgage and Securities Company, being wholly owned by it and organized by it for the purpose of doing business in Texas, and all the money loaned by the Southern Mortgage Company was procured from Mortgage and Securities Company.

On June 25, 1929, the company last named sold and delivered the twenty-two first lien notes to plaintiff in error, Mrs. Ethelyn West, who bought them for her sisters, plaintiffs in error Mrs. Morris and Mrs. Barham, paying for the same their full face value, the principal and accrued interest. The notes had been indorsed without recourse by Southern Mortgage Company, and their payment was guaranteed by Mortgage and Securities Company. A short time thereafter Mortgage and Securities Company failed and its property was placed in the hands of a receiver. The church received nothing for the notes.

This suit was filed by the church against the two mortgage companies, the receiver of Mortgage and Securities Company, the manager of Southern Mortgage Company, Mrs. West and her sisters, Mrs. Morris and Mrs. Barham, and several individuals who constituted The Taft Bank, Unincorporated. The relief sought is cancellation of the notes and the deeds of trust and the removal of clouds from the property of the church. In the alternative, and in the event the notes and deeds of trust are determined to be valid obligations and liens, the church seeks judgment against the two mortgage companies and the manager of Southern Mortgage Company for the amount so determined, with foreclosure of a lien upon any property of the two companies which might be disclosed or discovered.

By cross action Mrs. Morris and Mrs. Barham allege their ownership of the twenty-two notes, and of the lien securing them, and that they purchased the notes before maturity for value and with no knowledge or notice of the alleged infirmities, and they pray for judgment for the principal of the notes, interest, attorneys fees, and for foreclosure of lien.

The Taft Bank alleges the advancement of funds by it for labor and material aggregating about $24,000, that it has a lien sécuring same which is superior to the lien claimed by Mrs. Morris and Mrs. Barham, and prays for judgment against the church for the amount advanced, with interest and attorney’s fees, and for foreclosure of lien.

The case was tried without a jury, the trial court making elaborate findings of fact and conclusions of law. Judgment was rendered cancelling the twenty-two notes held by Mrs. Morris and Mrs. Barham and the deed of trust executed to secure the notes, and also cancelling the two notes aggregating $1,000 held by Southern Mortgage Company and the deed of trust executed to secure them; and judgment was rendered in favor of The Taft Bank against the church for $22,300, with interest, and for foreclosure of lien upon the property of the church. The church dismissed its suit against the manager of Southern Mortgage Company, and it was adjudged that it take nothing by its alternative suit.

The trial court found that the notes were negotiated and sold by the two mortgage companies to Mrs. West in violation of the agreement under which they were executed and delivered, and in fraud of the rights of the church; that the proceeds of the notes were appropriated by Mortgage and Securities Company; and that the church never received any part of the proceeds of the notes, or any consideration for them.

The trial court further found that at the time she purchased the notes for her sisters Mrs. West “had actual knowledge of the fact that the notes were for a construction loan, that said loan was not completed, that said notes were not ready for negotiation, and that same were not in fact then negotiable”; and also that “defendants Mrs. West, Mrs. Morris and Mrs. Barham, at the time the notes were purchased by them and delivered to them, as aforesaid, took same with notice of the defects in the title of Mortgage and Securities Company mentioned' in preceding paragraphs of these findings, and did not purchase same without notice in good faith and are not purchasers in good faith for value or holders in due course.”

The Court of Civil Appeals on first hearing reversed and remanded the cause, holding that there was no evidence charging Mrs. West and her sisters with fraud or bad faith, and that they were innocent purchasers of the notes for value before maturity. On rehearing the. judgment of the trial court was affirmed, the majority of the Court of Civil Appeals holding that there was evidence sufficient to sustain the finding of the trial court upon the issue of bad faith. 42 S. W. (2d), 1078.

Within the terms of the negotiable instruments law there was infirmity in the notes and the title of Mortgage and Securities Company which negotiated them was defective, because it had been agreed that the notes were to be held and not negotiated until the building was completed and the money represented by the notes paid, and because the notes were negotiated in violation of this agreement, in breach of faith and in fraud of the church. Secs. 52-55, Art. 5935, R. C. S., 1925.

The important question presented is whether there is any evidence to sustain the findings of the trial court that Mrs. West had actual knowledge of the infirmity or of the defect in the title and that she did not act in good faith in acquiring the notes.

By the terms of Section 52 of Art. 5935 one is not a holder in due course who, although he purchased a negotiable instrument before maturity and for value, had notice at the time it was negotiated “of any infirmity in the instrument' or defect in the title of the person negotiating it.”

■ Section 56 of the said Article is as follows:

“To constitute notice of an infirmity in the instrument or defect in the title of the person negotiating the same, the person to whom it is negotiated must have had actual knowledge of the infirmity or defect, or knowledge of such facts that his action in taking the instrument amounted to bad faith.”

The first inquiry is whether there is any evidence that Mrs. West at the time she purchased the notes had actual knowledge of- the infirmity or defect.

As has been stated, the infirmity in the notes was the agreement of Southern Mortgage Company that they would be held and not negotiated until the building was completed and the money represented by the notes paid to the church, and the defect in the title of Mortgage and Securities Company, which negotiated the notes, was that it negotiated them in violation of that agreement.

Neither Mrs. Morris nor Mrs. Barham had any connection with the negotiations by which the notes were acquired. Mrs. West acted for her two sisters, buying part of the notes for one and part for the other. The three sisters resided in Louisiana. None of them had any acquaintance with or in Taft, Texas. They had no communication with the church at Taft. Mrs. West had bought other notes from Mortgage and Securities Company. The representatives of that company knew that she would take no construction loans, that is, loans secured by buildings to be completed.

The notes were first presented to Mrs. West in the early part of May, 1929, by one Wood, who was a salesman for Mortgage and Securities Company. He submitted to her and left in her possession for examination a prospectus of the loan, the written application of the church to Southern Mortgage Company for the loan, and certain other written and printed information. The application described the notes to be executed, stating that they were to be dated on or about May 1, 1929, and would be secured by a deed of trust upon the property owned my the church, describing it, and that the lots would be improved by a two-story and basement brick church building estimated to cost $37,500. It stated that the building would be completed on or before July 1, 1929. Contrary to the agreement between the church and Southern Mortgage Company that no money would be advanced until the building was finished, the application stated that the proceeds of the loan would be available as the construction proceeded, no payment to be made, however, until construction had reached the point where the net proceeds to' be advanced by the mortgage company would complete the building and that 15% of the total amount of the contract price should remain in the hands of the mortgage company until completion of the work and final inspection.

Mr. Wood testified substantially as follows: That he showed Mrs. Wést the data which he had received from the files of Mortgage and Securities Company, including the application for the loan; that he discussed the merits of the loan with Mrs. West, but did not recall making any particular statements or representations to her concerning the notes or the deed of trust other than what was shown in the data submitted to her; that he was informed while handling the account of Mrs. West and her sisters that all securities purchased by them must be on completed properties and not on properties in process of construction; that when he made the preliminary offering of the loan he knew that the building was in process of construction, but when the notes were delivered to her he was convinced that the building had been fully completed; and that at the time he delivered the notes and accepted payment for them he did not know that the "money represented by the notes had not been paid to the church and did not advise Mrs. West that it had not been paid.

Mr. Jackson, vice-president of Mortgage and Securities Company, testified that sometime before the notes were sold Mrs. West asked him' whether or not he considered the Taft church loan a sound one, and he told her he considered it a good loan when ready for delivery, and that he made no other statements to her as to the loan, the notes or the deed of trust.

Mrs. West, after going over the instruments left with her and considering the loan for three or four days, advised Mr. Wood that she would take the loan when it was ready for delivery. About six weeks after her first conversation with Mr. Wood he telephoned her that the loan was ready for delivery. Thereupon she went to the office of the Mortgage and Securities Company, examined the notes, the indorsement of Southern Mortgage Company, and the guaranty of Mortgage and Securties Company, and completed the purchase. She made no inquiry about the building or the loan of any other person than those who represented the mortgage company with which she dealt. She did not undertake by correspondence or otherwise to ascertain whether the building had been completed or whether it had been erected at all. She testified that she relied upon the statment made to her by Mr. Wood that the loan was ready for delivery; that nothing had occurred to cause her to be suspicious about the legality or validity of the notes; and that she did not know that the church had raised any question as to the notes until a short time before this suit was filed.

■ Mrs. West, when interrogated on cross examination as to> her knowledge with respect to the notes, testified as follows:

“As to whether or not it struck me as being worthy of investigation that the application showed that it was a construction loan, I desire to state that the loan was not to be bought by me until it was a finished thing. I knew at the time it was. first presented to me that was not a finished thing. When. Mr. Wood first approached me with reference to buying these notes and exhibitied to me the papers, including the application, I did look it over. I wanted to see what security I was. getting. From that application I saw it was on a building not yet completed. I thought the application stated that the building had not yet been completed. I did not know that it had. not been started. At the time he first presented the loan to me he did not offer it for sale. He gave me these notes, if I wanted the loan, when it was a finished thing. He gave me that prospectus and this descriptive matter and this application so I could go over it and consider it and determine if I wanted the loan when it was finished. With reference to my taking his word for it when he told me the loan was finished,, I had no reason to doubt his statement. I took the notes. I had this application in my possession at that time, but I had. every reason to belieive the building was completed. * * *

“With references to my making any attempt to ascertain whether or not this church building had been erected as contemplated to be erected and completed, I desire to state that Mr, Wood had called me and said that the building was completed and that the loan was ready for delivery. It was perfectly understood by me and everybody in the Mortgage & Securities Company that I would take no loan except completed loans. * * *

“With reference to whether or not I made any attempt to ascertain from the officials of this church whether or not that building had been completed, and with reference to whether or not I merely took the word of Mr. Wood that the loan was. ready for delivery, I desire to state that I took the word of a supposedly reputable man. * * *

“ * * I did ask for a picture of the completed church. When, the notes were being delivered to me I saw Mr. Ogden when I got up to léave with the notes. He asked me if Mr. Wood fixed me up all right and I said, ‘Yes, but I want a picture of the finished church.’ I told him that I had just bought the First Baptist Church of Taft notes, and he said, ‘You have hot got it?’ and I said ‘No, and I want it,’ and he said, ‘We will have to get it for you,’ and I said, T want Mrs. Morris and Mrs. Barham to see- the church upon which they have loaned their money.” He told me that he thought he would get it for me in about a week. * * * '*

“ * * With reference to whether of not it occurred to me that the best source of information with reference to the character of the building and as to whether or not the building had been completed and had been accepted by the First Baptist Church of Taft as completed would be the officers of that, church, I desire to state that I had no reason to doubt any of the representations that were made by an entirely responsible company. * * * With reference to whether or not I knew as a matter of fact that if that building had not been completed there would have been a question raised about those securities, I had no knowledge of any dealings between Mortgage & Securities Company and the Church of Taft, Texas. * * * ■’

Mrs. West testified with reference to another loan offered her:

“I said to him, ‘That loan was offered to us before, and it is a construction loan, and I said I would not touch a construction loan with a forty foot pole.’ ”

It is apparent from the testimony of Mrs. West and the other two witnesses, as above quoted and stated, that in their use of such phrases as “the loan is not ready for delivery,” '“the -loan is not a finished thing,” and the like, they were referring to the fact that the building was not completed and that, knowing that Mrs. West would not accept a construction "loan or one secured by an unfinished building, they meant to rsay that the notes therefore were not ready for delivery to her. 'Thus the information which she acquired from the application :for the loan and from the statements made to her by the representatives of Mortgage and Securities Company was that when the notes were first presented to her the building was not completed and that at least a part of the consideration for the notes had not been paid by the mortgage company. She knew that the consideration was executory or in part executory. But this did not amount to knowledge that there would be a breach «of the mprtgage company’s executory obligation. Knowledge that a note was given in consideration of the executory agreement of the payee will not deprive the indorsee of the character of a holder in due course unless he has notice of a breach of such agreement. In the absence of knowledge or notice of a breach he may presume that the agreement will be performed as stipulated. Lozana v. Meyers (Com. App.), 18 S. W. (2d), 588; C. H. Mount joy Parts Co. v. San Antonio National Bank, 12 S. W. (2d), 609; Forster v. Enid, etc. R. Co. 176 S. W., 788; Buchanan v. Wren, 10 Texas Civ. App., 560, 30 S. W., 1077; 3 R. C. L., p. 1067.

The fact that the building was unfinished, in the absence of knowledge of the oral agreement to hold the notes, in no way-affected the negotiability of the notes. There is no evidence: that Mrs. West ever knew of the agreement between the church, and Southern Mortgage Company that the notes would be held at Abilene and not negotiated until the building had been completed and the money paid. The finding of the trial court that Mrs. West and her sisters knew at the time of their purchase, of the notes of the infirmity in them and of the defect in the title of the mortgage company is not supported by evidence.

The second inquiry is whether there is any evidence that Mrs. West, at the time the notes were acquired, had knowledge.of such facts that her action in taking them amounted to bad faith.

The trial court found both actual knowledge of the infirmity and defect in title and bad faith on the part of Mrs. West. The affirmance by the Court of Civil Appeals appears to rest upon the conclusion that there was evidence sufficient to support the trial court’s finding that Mrs. West acted in bad faith in acquiring the notes.

Judge Garrett, in Wilson v. Denton, 82 Texas, 531, 535, 18 S. W., 630, thus stated and explained the settled rule in this state and in practically all of the other states, and of which Section 56 of Article 5935 is but a restatement:

“The ordinary rule of constructive notice which applies te the purchase of property is not applicable in the case of negotiable instruments. As promotive of their circulation a liberal view is taken, which makes the bona fides of the transaction the decisive test of the holder’s right. He is entitled to recover upon it if he has come by it honestly. Greneaux v. Wheeler, 6 Texas, 525; 1 Dan. Neg. Inst., sec. 775. It matters not how the vendor came in possession of the bill or note, whether by-theft, or fraud, or honestly; the title of the transferee does not depend upon the title of the vendor, but upon his possession, and if the buyer has acted in good faith and paid a valuable? consideration his title can not be impugned. An early English, case (Gill v. Cubitt, 3 Barn. & Cress., 466,) laid down the principle, that although the holder had given value for the bill or note, yet if he took it under circumstances which ought to Rave excited the suspicions of a prudent and careful man, he could not recover. This was a departure from the earlier rule, which regarded the bonafides as the crucial test by which it was to be determined whether or not the purchaser should be protected against defenses that would be valid against the transferer of the note. But the earlier rule was soon again reverted to, and afterward made even more liberal, and it became the law, that while gross negligence might be evidence tending to show malei fides, and as such admissdble, it did not in itself